Future of ‘safe’ mortgages in CFPB’s hands

Consumer bureau writes rules to limit deceptive, complex mortgages

By

RonaldD. Orol

WASHINGTON (MarketWatch) — A regulation that may limit mortgage availability in the U.S. may soon be set by a new consumer watchdog agency, with both banking and borrower advocates furiously lobbying to make sure it suits their interests.

The recently formed Consumer Financial Protection Bureau is expected in the next few months to adopt a rule that would identify the criteria and characteristics for “qualified mortgages,” those deemed by the sweeping Dodd-Frank bank reform law that assures a borrower has a reasonable ability to repay the loan.

The chart of current loans through February 2012 shows mortgage owners are less likely to be 90 days or more late on their payments when they borrow 80% or less of the value of a home.

The goal of this measure is to eliminate the kinds of complex, deceptive loans, including so-called “liar loans,” that were key contributors to the financial crisis of 2008.

The provision is unusual because it was introduced by the Federal Reserve under Chairman Ben Bernanke in April 2011 and is set to be approved by the CFPB under its director, Richard Cordray. The shift in regulators is taking place because consumer protection regulatory authority was transferred last year. Observers say the CFPB could adopt the rule by June, but one possibility is for the agency to re-propose the regulation if it wants to make major changes to what the Fed drafted.

Proponents say the rule will drive lenders to make safer loans and prevent a future crisis. Critics worry that it may make it more difficult for responsible borrowers to obtain mortgages because lenders will be skittish about litigation costs and the kinds of loans they are willing to make. Because a borrower of a non-qualified mortgage could potentially win a judgement forcing a lender to pay off all the interest and principal, those types of mortgages would be virtually outlawed, said Joe Pigg, senior counsel of the American Bankers Association.

Both consumer groups and banks worry about narrow limitations such as the possibility of a national standard for how much debt a borrower could take out compared to their income, without considering regional housing price variations.

And the lobbying has been intense. Banking and consumer groups have sent numerous letters to the CFPB. ABA officials have had “multiple” meetings with consumer bureau staff to discuss the issue, including a meeting between Cordray and the lobby group’s chief executive, Frank Keating, this week, according to Pigg. Pigg said that he participated in three meetings on the issue at the CFPB, and ABA officials have had conversations about it with other Obama administration officials.

Meanwhile, consumer groups have been busy too. Kathleen Day, spokeswoman at the Center for Responsible Lending in Washington, said the qualified mortgage is a top priority for the non-partisan research and policy consumer group, and officials have met on several occasions with CFPB officials. David Berenbaum, National Community Reinvestment Coalition chief program officer, has met several times with CFPB officials to press for a broad measure and Barry Zigas at the Consumer Federation of America has gone twice.

A CFPB spokesperson declined to comment for the story. The bureau’s deputy director, Raj Date, said last month that the agency has undertaken a “significant analytical effort – with a cross-functional team of economists, lawyers, and market experts” on the issue. Speaking to the Greenlining Institute, Date said the bureau wants to ensure that consumers are not sold mortgages they don’t understand and cannot afford but also ones that have the benefit of “sufficient investor appetite and a competitive market.”

Ralph Axel, analyst at Bank of America Merrill Lynch in New York, said a restrictive qualified mortgage definition could have a similar negative impact on the overall mortgage market that was seen in the government-backed market between Fannie Mae and Freddie Mac loans, which have introduced tougher underwriting standards, and Federal Housing Administration ones that had more expansive qualifications.

The FHA’s market share for government-backed mortgages has climbed from 9% in the fourth quarter of 2007 to 22% in the fourth quarter of 2011, according to SIFMA data. “This demonstrates the impact of tightening which I think is a key risk of future potential reforms,” said Axel.

The law provides some specific and some vague conditions to qualify, leaving it up to regulators to fill in the blanks. Loans central to the financial crisis aren’t permitted to qualify, such as negative amortization loans and mortgages with balloon payments or teaser rates.

Standard five-year adjustable-rate mortgages and 30-year fixed interest-rate mortgage should be the kind of loan that qualifies, said Michael Barr, a former assistant secretary for financial institutions at the Obama administration Treasury Department.

However, bankers are raising concerns about what kind of adjustable rate mortgages will be allowed.

Thomas Cronin, managing director at the Collingwood Group Inc. in Washington, said that the CFPB could allow ARM mortgage interest rates to increase but with a some sort of limitation or cap of 7% or 10% interest, for example.

The ABA’s Pigg said a five-year adjustable mortgage is suitable for some borrowers such as those who take short-term jobs and have plans to sell their home within five years.

Pigg pointed out that interest rates are extremely low currently, making 30-year or 15-year mortgages attractive, but as rates rise ARMs might become more eye-catching because of their lower rates, and eliminating some types of ARMs could hurt home ownership.

The future of down-payment costs

Most regulatory observers say it is unlikely that the CFPB will impose a down-payment requirement for the qualified mortgage, at least not one that doesn’t come with other conditions.

One complication is that a related proposal under consideration by bank regulators comes with a 20% down-payment requirement.

That regulatory proposal, introduced over a year ago, requires banks to retain some of the risk of loans they package and sell. As part of the measure, regulators have also proposed a rule that would allow some high-quality mortgages known as “qualified residential mortgages” with 20% down-payments to be exempt from risk retention.

(The goal of risk-retention -- also known as skin-in-the-game -- is to eliminate a problem leading to the financial crisis where lenders packaged and sold sub-prime mortgages they knew would fail). Read about 'skin-in-the-game' proposal

Barr says some down-payment should be considered within the context of other factors such as a borrower’s debt-to-income ratio and documented income, Barr said.

“If you have a mortgage that has a zero down-payment and a borrower with a high debt-to-income ratio and no income documentation then you have the sub-prime crisis all over again,” said Barr. “Having a down-payment requirement of some kind can be an important way of improving a borrower’s incentive to re-pay, but it is not the only way of doing that if they have other ways of making ends meet.”

Debt to income

The statute also requires lenders to verify that the borrower has the income they say they have.Some observers are concerned that Cordray could impose stringent limitations on how much debt a borrower is allowed to take on compared to their income.

Amy Friend, who was chief counsel of the Senate Banking Committee between 2008 and 2010 during the writing of the Dodd-Frank Act and is, now a managing director at consulting firm Promontory Financial, said the CFPB may add details to a provision allowing borrowers to take out loans only if their debt is low compared to their income.

The bureau may adopt debt-to-income ratio standards for borrowers that already exist for Fannie Mae and Freddie Mac mortgages, which currently are between 33% and 36%.

But NCRC’s Berenbaum said a national debt-to-income standard of that sort would hurt access to credit for creditworthy borrowers in communities with expensive housing. He suggested that the CFPB set up regional debt to income standards because borrowers in some costly communities may need to put up as much as 43% of their income to buy a home.

Housing and Urban Development Secretary Shaun Donovan recently urged regulators not to make the qualified mortgage rule overly restrictive. At a hearing on April 26, he said the definitions will be critical for developing a privatized mortgage securitization market.

Rebut this

A core debate at the CFPB is whether it will give lenders a “safe harbor” from liability or allow borrowers to have a “rebuttable presumption,” where they can have a a better ability to challenge the lender on the loan.

Banking groups such as the American Bankers Association say that a safe harbor against litigation, essentially immunity against litigation, is critical to allowing them to make affordable loans to creditworthy borrowers without fear of litigation. Meanwhile, consumer groups are pushing for a rebuttable presumption, saying that provision would pressure banks to make loans that meet the prescribed qualifications.

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